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What's the value of the $159,794 per share disclosed in the annual report?


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I see lots of people simply add the value of the cash plus investments per share disclosed by Berkshire to a multiple of Berkshire's pre-tax operating earnings to get the value of the stock. (I think the numbers adjusted for PCP should be roughly $145k and $13,498 per share.)

 

However, my sense is that it's unlikely that the per-share investments can really organically compound at greater than a 6-7% rate right?  If they've got 40% in equities and 60% in cash and fixed-income, then if equities do 12% over time and cash and fixed income does ~3%...then really you're looking at ~6.6% pre-tax returns reinvested at ~6.6%  (and then on the liability side they've got this nice fat deferred tax liability that comes along with it).  Personally, I value that less than $159,794 per share.

 

So if 12x (~8% equity return) is a fair market multiple of P/E to apply to a stable company that is distributing 100% of its earnings, then maybe one that is reinvesting it at 6.6% should get a 9.9x multiple on earnings, or said differently that per share amount should be valued at $131,830    ( = 9.9/12*$159,794) .

 

I think I tried to measure their investment per share performance over the last 5 years but since they've been reallocating some of their cash into operating businesses, its a little bit hard to figure out what the performance of their marketable securities have been historically.  I think you used to be able to just look at the per-share investments, but now its not fair to do that anymore. Additionally the growth of the float has slowed.

 

I don't know.  what are board's thoughts on that $159k per share?  Thanks for indulging me.

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If they've got 40% in equities and 60% in cash and fixed-income, then if equities do 12% over time and cash and fixed income does ~3%...

 

I can't comment on your question. But I don't agree with your logic.

 

Assume that you have a holding company that owns $100M worth of 10 year U.S. bonds (yielding 1.5%). Your pre-tax earnings are $1.5 M. Slap a 10x multiple on these earnings. Now your $100M bonds are only worth $15 M.

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My exact point is that the value to me is not determined by the quoted market price. When you say $100M "worth" of bonds, you're talking about the market's appraisal of it. 

 

Just to put structure to it:

 

If the holding company holds bonds that have

 

1) 1.5% coupon  2) $100M face value  3) is as risky as an unlevered equity of the same company, and 4) I intend to hold your company's shares till the bond's maturity

 

then absolutely I would only buy your holding company for $15M.  Because I would choose to make 10% return on my capital, not 1.5%.  I don't care if the market would outbid me by $85M for the same company.  (This is just to simplify the exercise and drive the point home - yes I realize bonds are generally less risky because they are higher in absolute priority so maybe you slightly lower return requirement ). 

 

Asked differently, which would you rather have Berkshire hold for the next 5 years if you're an investor?  $159k per share in cash, or $159k per share in carefully chosen equities?  Would you assign the same value to both outcomes if you were considering buying the stock?  Certainly the latter would make you wealthier in 5 years.

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If they've got 40% in equities and 60% in cash and fixed-income, then if equities do 12% over time and cash and fixed income does ~3%...then really you're looking at ~6.6% pre-tax returns reinvested at ~6.6%

 

The cash and fixed income earning 0-3% is, for the most part, a holding place for them to buy more equities or companies with. So you can't value it by placing a multiple on the 3% interest rate.

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Well $20B is the minimum cash they'll hold to maintain a fortress balance sheet and the fixed income portfolio is there to maintain adequate additional liquidity to pay an ongoing stream of insurance claims.  So as long as interest rates are low, all insurers suffer because they have to be liquid to pay a stream of claims and they earn very low rates on that excess liquidity.

 

So fixed income is not placeholder..cash + fixed income has been generally been equal to float, or roughly 50% -60% of the investment book.  It's a function of having an insurance business.  So no, its not temporary.

 

Now they'll earn an additional few billion from underwriting as well, but we're already counting that in our operating earnings.

 

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3) is as risky as an unlevered equity of the same company,

 

This is my point. You are implicitly applying an equity risk premium to cash and bonds. You need to risk-adjust your discount rate.

 

I don't want to get too off-topic here, but just on this point, I don't think that one should automatically charge a lower rate to hold a bond than a stock. Or said differently, one should not automatically discount interest payments at a lower rate than earnings.  Certainly when discussing a particular company, its bond is necessarily safer than its stock, but that doesn't mean all bonds, or a portfolio of bonds are automatically safer than a portfolio of stocks in general.  In fact, I would argue that a generic portfolio of bonds is far less safe today than a generic portfolio of equities.  The rates are low enough on average, bond holders are not getting compensated for the risks of default and the loss given default.  Yet they're hungry for the illusion of guaranteed income so they continue to lend at absurd rates (negative in Europe).

 

Consider two hypothetical auto companies A and B - each is like the other... both are highly cyclical in a commodity business earning 10% on capital.  If A is capitalized with fixed rate senior debt at 7%, junior debt, and equity ....and B is capitalized only with equity...well in my mind, the junior debt of A, is far riskier than the equity of B, even though the junior debt of A is a bond and the equity of B is an equity.  Inevitably both auto companies will have a loss making year, but A is more likely to go bankrupt if it can't service its senior debt.  B is less than likely than A to go bankrupt.  The bond of A in this case is far more risky than the equity of B.

 

I'm getting pedantic , so just to bring it back to the per-share cash and investments of Berkshire, I consider the investment portfolio a ~6.5% return machine that is generally safe from a credit standpoint, whether my returns come in the form of interest or dividends or appreciation, it doesn't matter anyway.  It's all retained and reinvested at roughly that 6.5%-7% rate. What do we pay for that? 

 

Another way to ponder over the same problem is:

 

Consider two holding companies.  1) The first holds $100M in cash and will sit on it for 5 years.  2) Holds $100M of cash, and Lou Simpson will work for no salary to deploy it on day 1.  Which one is worth more and how much more do you pay?  In this case, $100M today will have very different paths in the future, so you can't just take $100M cash as worth $100M.

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How come risk is not in this discussion? Such as for example that these equity returns are variable. Or that the cash might yield 10% at some future date (I know seems unlikely now). Or that my expected horse (not Berkshire) fails to meet my expectation while I watch Berkshire whizz by on an elephant. But yeah, nobody doubts that Berkshire is not going to return the highest in the market, but for many it's the best they can do. And even for some that think they can do better (look at some of the hedge fund records).

 

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How come risk is not in this discussion? Such as for example that these equity returns are variable. Or that the cash might yield 10% at some future date (I know seems unlikely now). Or that my expected horse (not Berkshire) fails to meet my expectation while I watch Berkshire whizz by on an elephant. But yeah, nobody doubts that Berkshire is not going to return the highest in the market, but for many it's the best they can do. And even for some that think they can do better (look at some of the hedge fund records).

 

I don't know that Berkshire is going to have the highest return or not.  It's somewhat undervalued.  Internally I don't think it'll compound overall at more than a low double rate. And that's only because they're levering the operating side. 

 

Yeah, we don't know the future outcomes of anything - Berkshire or otherwise.  But you have to have a conservative return expectation and mitigate the downside with price you pay for Berkshire stock.  If cash rates go to 10%, then the stocks/bonds marks will temporarily tank.  But future returns on the investment side will be far greater going forward. I personally don't care about market marks.  I care about internal rates of return from holding investments.

 

Acknowledging that equity returns are more variable, in a portfolio they'll still likely return more than cash with no more risk of impairment.  In other words, even if you threw 15 darts on a board  to pick stocks and just held those 15 stocks for 20 years without knowing anything about them, even if three of them ended up going bankrupt, you would still earn an ok return.  Sure the equity book might be more "volatile" than cash but volatility isn't risk. The over all portfolio will still go up.

 

Acknowledging the risk that Berkshire won't necessarily achieve expectations, I think you can only control that by having conservative base case expectations and then paying a low price.  That being said, i'm not clear as to how this affects the $159k calc.

 

 

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The bulk of the BRK ‘value’ is off-book & not represented anywhere on their financials.

It is their reputation, long term approach, ability to do big transactions, the fact that everybody is getting old - & the likelihood that BRK may well be broken up into smaller more manageable units, once the masters are gone. That’s not a bad thing, & many would argue – long overdue.

 

More than a few have suggested, at various times, that the world is currently going through the greatest depression in history; that big cash balance is a very nice thing to have, & the ability of the subs to borrow in a big way – is simply icing on the cake. The strategic value is enormous.

 

You could park your $ in a US treasury, or BRK; for many the risks are about the same. If you think the masters are wheezing a bit more than they used to –adjust your weighting accordingly.

 

SD 

 

 

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The bulk of the BRK ‘value’ is off-book & not represented anywhere on their financials.

It is their reputation, long term approach, ability to do big transactions, the fact that everybody is getting old - & the likelihood that BRK may well be broken up into smaller more manageable units, once the masters are gone. That’s not a bad thing, & many would argue – long overdue.

 

More than a few have suggested, at various times, that the world is currently going through the greatest depression in history; that big cash balance is a very nice thing to have, & the ability of the subs to borrow in a big way – is simply icing on the cake. The strategic value is enormous.

 

You could park your $ in a US treasury, or BRK; for many the risks are about the same. If you think the masters are wheezing a bit more than they used to –adjust your weighting accordingly.

 

SD

 

I sure hope they don't break up BRK, it is working just fine. The fact is that the whole is >>sum of the parts is not so valued by the market, it will, in due course.Berkshire is bearing down on the weighing scale and it will register. Besides, Buffett and the charity holdings will just about make any break up improbable for a  while longer. So all opinion of a breakup can remain just opinion.  Trillion first!

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My exact point is that the value to me is not determined by the quoted market price. When you say $100M "worth" of bonds, you're talking about the market's appraisal of it. 

 

Just to put structure to it:

 

If the holding company holds bonds that have

 

1) 1.5% coupon  2) $100M face value  3) is as risky as an unlevered equity of the same company, and 4) I intend to hold your company's shares till the bond's maturity

 

then absolutely I would only buy your holding company for $15M.  Because I would choose to make 10% return on my capital, not 1.5%.  I don't care if the market would outbid me by $85M for the same company.  (This is just to simplify the exercise and drive the point home - yes I realize bonds are generally less risky because they are higher in absolute priority so maybe you slightly lower return requirement ). 

 

Asked differently, which would you rather have Berkshire hold for the next 5 years if you're an investor?  $159k per share in cash, or $159k per share in carefully chosen equities?  Would you assign the same value to both outcomes if you were considering buying the stock?  Certainly the latter would make you wealthier in 5 years.

If I'm understanding your hypothetical scenario, it sounds like a situation you could pay well in excess of 15mm and very safely earn far higher than 10%.

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My exact point is that the value to me is not determined by the quoted market price. When you say $100M "worth" of bonds, you're talking about the market's appraisal of it. 

 

Just to put structure to it:

 

If the holding company holds bonds that have:

 

1) 1.5% coupon  2) $100M face value  3) is as risky as an unlevered equity of the same company, and 4) I intend to hold your company's shares till the bond's maturity

 

then absolutely I would only buy your holding company for $15M.  Because I would choose to make 10% return on my capital, not 1.5%.  I don't care if the market would outbid me by $85M for the same company.  (This is just to simplify the exercise and drive the point home - yes I realize bonds are generally less risky because they are higher in absolute priority so maybe you slightly lower return requirement ). 

 

Asked differently, which would you rather have Berkshire hold for the next 5 years if you're an investor?  $159k per share in cash, or $159k per share in carefully chosen equities?  Would you assign the same value to both outcomes if you were considering buying the stock?  Certainly the latter would make you wealthier in 5 years.

If I'm understanding your hypothetical scenario, it sounds like a situation you could pay well in excess of 15mm and very safely earn far higher than 10%.

 

yeah you're right.  I didn't verify the math. I guess I could pay at most $48M to earn 10% or greater, as long as I could re-invest my coupons at 10%.

 

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My exact point is that the value to me is not determined by the quoted market price. When you say $100M "worth" of bonds, you're talking about the market's appraisal of it. 

 

Just to put structure to it:

 

If the holding company holds bonds that have:

 

1) 1.5% coupon  2) $100M face value  3) is as risky as an unlevered equity of the same company, and 4) I intend to hold your company's shares till the bond's maturity

 

then absolutely I would only buy your holding company for $15M.  Because I would choose to make 10% return on my capital, not 1.5%.  I don't care if the market would outbid me by $85M for the same company.  (This is just to simplify the exercise and drive the point home - yes I realize bonds are generally less risky because they are higher in absolute priority so maybe you slightly lower return requirement ). 

 

Asked differently, which would you rather have Berkshire hold for the next 5 years if you're an investor?  $159k per share in cash, or $159k per share in carefully chosen equities?  Would you assign the same value to both outcomes if you were considering buying the stock?  Certainly the latter would make you wealthier in 5 years.

If I'm understanding your hypothetical scenario, it sounds like a situation you could pay well in excess of 15mm and very safely earn far higher than 10%.

 

yeah you're right.  I didn't verify the math. I guess I could pay at most $48M to earn 10% or greater, as long as I could re-invest my coupons at 10%.

Do some research on arbitrage (not saying that in a sarcastic way at all). You could pay a way higher price and still achieve 10%. Ignoring double taxation as your hypothetical was for conceptual illustration not details. Arbitrage isn't really the point though, the point is market prices and different amounts of risk in the underlying investments matter. And risks can often be hedged (if desired).

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My exact point is that the value to me is not determined by the quoted market price. When you say $100M "worth" of bonds, you're talking about the market's appraisal of it. 

 

Just to put structure to it:

 

If the holding company holds bonds that have:

 

1) 1.5% coupon  2) $100M face value  3) is as risky as an unlevered equity of the same company, and 4) I intend to hold your company's shares till the bond's maturity

 

then absolutely I would only buy your holding company for $15M.  Because I would choose to make 10% return on my capital, not 1.5%.  I don't care if the market would outbid me by $85M for the same company.  (This is just to simplify the exercise and drive the point home - yes I realize bonds are generally less risky because they are higher in absolute priority so maybe you slightly lower return requirement ). 

 

Asked differently, which would you rather have Berkshire hold for the next 5 years if you're an investor?  $159k per share in cash, or $159k per share in carefully chosen equities?  Would you assign the same value to both outcomes if you were considering buying the stock?  Certainly the latter would make you wealthier in 5 years.

If I'm understanding your hypothetical scenario, it sounds like a situation you could pay well in excess of 15mm and very safely earn far higher than 10%.

 

yeah you're right.  I didn't verify the math. I guess I could pay at most $48M to earn 10% or greater, as long as I could re-invest my coupons at 10%.

Do some research on arbitrage (not saying that in a sarcastic way at all). You could pay a way higher price and still achieve 10%. Ignoring double taxation as your hypothetical was for conceptual illustration not details. Arbitrage isn't really the point though, the point is market prices and different amounts of risk in the underlying investments matter. And risks can often be hedged (if desired).

 

I'm not exactly sure what you mean.  Care to elaborate with an example? 

 

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I see lots of people simply add the value of the cash plus investments per share disclosed by Berkshire to a multiple of Berkshire's pre-tax operating earnings to get the value of the stock. (I think the numbers adjusted for PCP should be roughly $145k and $13,498 per share.)

 

However, my sense is that it's unlikely that the per-share investments can really organically compound at greater than a 6-7% rate right?  If they've got 40% in equities and 60% in cash and fixed-income, then if equities do 12% over time and cash and fixed income does ~3%...then really you're looking at ~6.6% pre-tax returns reinvested at ~6.6%  (and then on the liability side they've got this nice fat deferred tax liability that comes along with it).  Personally, I value that less than $159,794 per share.

 

So if 12x (~8% equity return) is a fair market multiple of P/E to apply to a stable company that is distributing 100% of its earnings, then maybe one that is reinvesting it at 6.6% should get a 9.9x multiple on earnings, or said differently that per share amount should be valued at $131,830    ( = 9.9/12*$159,794) .

 

I think I tried to measure their investment per share performance over the last 5 years but since they've been reallocating some of their cash into operating businesses, its a little bit hard to figure out what the performance of their marketable securities have been historically.  I think you used to be able to just look at the per-share investments, but now its not fair to do that anymore. Additionally the growth of the float has slowed.

 

I don't know.  what are board's thoughts on that $159k per share?  Thanks for indulging me.

 

I think the $145k per share will continue to grow due to appreciation of the equity portfolio and the free cash flow that will continue to build.  Ideally, the current cash and future cash flows will be used for the acquisition of new operating businesses.

 

The $145,000/share cash/investments currently consists of the approximately $110 billion equity portfolio and $128 of cash/fixed income.  With the KHC preferred being repaid and free cash flow, I think cash is probably back close to $70 billion. 

 

How will the 2 column components look in 5 years?

 

If pre tax operating profits organically increase 4% annually, the per share numbers will go from 13,500/share to $16,400/share

In addition, I think there is something like $1 billion/month ($12B annually) of free cash flow coming in from the operating businesses.  Lets say Buffett is able to use all of that free cash flow and $30 billion of the current cash hoard to add to the operating businesses for a total of $90 billion.  If Buffett's hurdle rate for acquisitions is 10% pre tax returns it would add $9B pre tax profit to the operating column.

 

After 5 years with these assumptions Cash/investments would be $166,000/share and Pre tax operating income of $21,877/share.  Annual increases of 3% and 10%

 

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This is basically how I do my calc too generally.  However...

 

I think if you are growing the investment book from $145k to $166k, that's likely too conservative.  the equity book, at 10% per year, will add $37k per A share alone.  And then fixed income may add 3% per year..and float growth may add a point or so, which would be reinvested in marketable securities in the same proportion of FI to Equity presumably.

 

Also on the operating side, even if pre-tax returns are 10% unlevered, berkshire is consistently levering them by issuing bonds and then reinvesting that levered capital.  Some big users of capital; BNSF  / BHE / Van Tuyl /PCP ...so maybe overall organic and acquired earnings growth is closer to 15%. 

 

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